Anthony Browne MP is Chair of the 1922 Treasury Committee, a former member of the Treasury Select Committee, and on the advisory board of the Institute of Fiscal Studies.
When Peter Jay was the Economics Editor at the BBC, and I was reporting economics there, he once said to me that the collapse of communism had “taught us that incentives matter”.
Well, blow me down. That is one of the fundamental reason why I am Conservative: we understand that incentives matter, and you have to work with the grain of them rather than work against them. It is that insight that leads to belief in free enterprise and free markets; it is Labour’s and the left’s blind spot. We understand that the Laffer curve has a peak, but Labour doesn’t. During the 1970s, Labour brought in the infamous 98 per cent supertax on investment income, almost designed to kill off investment.
Understanding the importance of incentives influences a whole range of economic and social policies. When I was responsible for the London Development Agency, I inherited a regime from Ken Livingstone that dished out millions of pounds in grants to companies, totally distorting their incentive structure: many small businesses then spent all their managerial effort applying for new grants, rather than producing goods and services that customers actually wanted to buy. Some completely lost sight of their customers and collapsed.
Enabling people to earn more on benefits than they can get from working will lead (in Tony Blair’s wording) to languishing on benefits. Many decades ago, I once had a period of unemployment, and then declared to the Job Centre some freelance income: I lost over 95 per cent of my earnings through benefit reductions. I left the Job Centre stunned, thinking that it was teaching me that I must not do any freelance work. Thankfully, the Conservative Universal Credit has stopped those extremes. Work must pay.
To fund public services, we need to raise large sums from taxation, but we should aim to do it in a way that maximises incentives for beneficial behaviour, and minimises incentives for damaging behaviour – taxing bads rather than taxing goods. Tax cigarettes as much as possible, for example, not work.
This is why we need to keep marginal rates of taxation down: enabling everyone to keep as much of what extra they earn as possible to encourage them to work. There is also, for me, a moral point: if someone works, they should be the main beneficiary of their labour, rather than being forced to give most of their extra earnings to the Government.
But the increasing demands for tax revenues, and the rising concentration of taxation on higher earners over the last 20 years, has lead to some very high marginal rates of taxation. Because public debate has focused on the headline rates of taxation, and because of the complexity of our tax and benefits system, these extremely high rates of marginal taxation are often disguised, poorly understood and rarely commented on. But they are still there – and are very damaging.
George Osborne decided to withdraw the personal income tax allowance for those earning over £100,000. It might sound reasonable, but it was mathematically identical to bringing in a marginal rate of taxation of 60 per cent between £100,000 and £125,000, before the marginal rate drops back down to 40 per cent (since changed to 45 per cent). On top of that, you have employee national insurance of two per cent, giving a marginal rate of 62 per cent. If those in question are also repaying a student loan at nine per cent of their income, they would have a marginal rate of 71 per cent.
Immediately before becoming an MP, I was a contractor who, when you added in VAT deduction (I couldn’t reclaim), was faced with marginal rates of 68 per cent: if a company paid me £100, then the Government would take £68, and I would be left with just £32. Apart from the annoyance that the Government was taking two thirds of all extra I earned, it made me think: “what is the point in taking on more work? Why not just take more holiday?”.
Having such high marginal rates doesn’t just encourage people not to do more work, it really limits the incentive to increase your income by changing jobs, and limits the ability of companies to give pay rises that lead to more money entering employees bank accounts.
The highest marginal rates come when people also experience withdrawal of benefits, either universal credit or child benefits. When the Prime Minister was Chancellor, he rightly reduced marginal rates of withdrawal of universal credit to 55 per cent, but if you add in employee national insurance and the basic rate of income tax, you can get to marginal rates of 70 per cent.
If you have two children and earn between £50,000 and £60,000, then the High Income Child Benefit Charge (another Osborne policy) is effectively an additional tax of 18.3 per cent. If you are also a high rate tax payer and paying off a student loan then and you add in employee national insurance, your marginal rate of taxation can reach 69.3 per cent.
With the freezing of the tax thresholds, millions of more people are getting hit by these higher marginal rates of taxation. These are not millionaires paying these very high marginal tax rates, but contractors, middle managers, teachers and health workers. There is increasingly public awareness: the Times has even just started a campaign on the issue.
Conservative MPs, and the Treasury, are aware of all this. But what should be done? There is no simple silver bullet. If you pay benefits to people who are employed, as we do now to millions of people, then the only way to stop high marginal rates of taxation is to taper the withdrawal more slowly, which is not only expensive, but means people will still be receiving benefits at high rates of income.
But policy makers should still give greater priority to tackling higher marginal rates of taxation. The Treasury should explicitly address the issue in its budget Red Book. Ideally, the Conservative Party should adopt as a longer term objective that everyone should be able to keep at least half of what they earn, that they are the main beneficiaries of their overtime or pay rise, rather than the Government.
That would be a good Conservative message, aligning with our mission to support aspiration, and to help rather than punish those who do the right thing and work hard. If we wanted to draw a dividing line with the Opposition, we could highlight ourselves as the party of workers, not shirkers, of strivers not skivers.
In practical terms, it would mean having an ambition to bring all marginal rates of taxation below 50 per cent. Once you decide you want to do that, it leads of many possible options: reducing the withdrawal rate of High Income Child Benefit Charge, reducing the withdrawal rate for student loans; scrapping or limiting uncapped employee national insurance contributions. The 60 per cent tax rate for those earning between £100,000 and £125,000 could be scrapped. A possible approach to pay for this would be to scrap the 40% tax band outright, and reduce the threshold for the 45 per cent tax band so that people move straight from 20 per cent to 45 per cent.
All of these have costs, and winners and losers. They can be modelled, and then a decision made on which is the best affordable approach. It will take many years of consistent effort to bring all marginal rates below 50 per cent. But we could adopt it as an objective – and push a good Conservative vision of supporting work and aspiration.